Equities
Executive Summary Chinese Onshore Stock Prices And Earnings Are Set To Deteriorate Macro fundamentals indicate that for the time being there is no basis to overweight Chinese onshore stocks (in both absolute terms and relative to global stocks) given the outlook for profit growth contraction in 1H22. We are reluctant to shift our stance on Chinese domestic stocks to overweight in the next 6 to 12 months due to the following non-trivial risks: a subdued recovery in China’s economic activity, a deceleration in fiscal impulse in 2H22, a re-focus on reducing carbon emissions, as well as higher US bond yields and tighter global liquidity conditions. Despite a sharp drop in January, valuations in Chinese onshore stocks are still neutral in absolute terms, and only slightly cheaper than global stocks. As such, Chinese onshore stocks offer little valuation buffer in the wake of any negative surprises. Bottom Line: We maintain our underweight stance on Chinese onshore stocks (in both absolute terms and relative to global equities) due to non-trivial risks in the coming year. Feature China’s stock markets was very weak in the first month of 2022. The domestic equity market tumbled by 8% in January, while the offshore market dropped by 3%. We discussed our view on Chinese investable stocks in last week’s report and recommended that investors go long on investable value stocks versus growth stocks. This week’s report focuses on the onshore market. While we expect the economy to stabilize by mid-year on the back of increased policy support, we are reluctant to move to a cyclical overweight in the next 6 to 12 months, in both absolute terms and relative to their global peers. Near-term challenges in economic fundamentals will continue to weigh on Chinese domestic stocks. Over a cyclical time frame, the main risks to a bullish view on Chinese stocks are fourfold: a potentially subdued economic recovery; a sharp deceleration in fiscal impulse in the second half of the year; a re-acceleration in de-carbonization efforts; as well as higher bonds yields in the US and tighter global financial conditions. Chinese onshore stocks are not as deeply discounted as their offshore peers and, therefore, are less able to counter any negative surprises. Macroeconomics Matter Chart 1Weak Economic Fundamentals Undermine Stock Performance China’s economic fundamentals still drive corporate earnings and the country’s domestic stock performance, despite an escalation in monetary policy easing (Chart 1). Current macro fundamentals do not provide a legitimate support for investors to overweight Chinese stocks. The domestic stock market’s rocky start to 2022 underscores extremely fragile sentiment and heightened anxiety among investors. Credit growth bottomed in October last year but has not shown any signs of a strong rebound. Corporate demand for credit remains in the doldrums while turmoil in the housing market has disincentivized households from taking mortgages (Chart 2). The real economy, which in previous business cycles lagged credit growth by about six to nine months, has not responded to policy easing measures. Housing market indicators in January deteriorated further (Chart 3). Moreover, the nation’s counter-COVID measures have disrupted a recovery in the service sector and private consumption. Chart 2Demand For Loans Remains Weak Chart 3Housing Sales Weakened Further In January Chart 4Chinese Onshore Stock EPS Is Set To Deteriorate The financial market is forward looking and macro policies have become more market friendly. However, Chart 4 suggests that China's onshore corporate profits are set to deteriorate in the coming six months or so, and investors will likely react negatively to any further weakness in China’s measures of economic activity. Bottom Line: At the moment, China’s domestic economic fundamentals do not support an overweight stance in Chinese stocks. Mindful Of Cyclical Risks Chinese authorities have prioritized stimulating growth through countercyclical measures in 2022. However, we are reluctant to move to a cyclical overweight stance because we see four significant risks to turning bullish towards Chinese stocks (in both absolute and relative terms) in the next 6 to 12 months. These scenarios not only threaten the performance of Chinese stocks relative to global equities but could also prevent Chinese stocks’ absolute performance from trending higher. A subdued recovery in China’s economic activity. When policymakers wait too long to decisively stimulate the economy, business and consumer sentiment as well as the economy can remain downbeat for a prolonged period. For example, in the 2014/15 business cycle, monetary policy started to ease in early 2015, but policymakers hesitated to back down from supply-side reforms. As a result, the economy did not bottom until Q1 2016. Business activity and the financial markets reached their lows only after the authorities opened the “flood irrigation” to the economy by massively stimulating the housing sector (Chart 5). Arguably China’s economy is in a better shape now than in 2014/15 and the ongoing economic slowdown is not the result of a four-year downtrend in industrial activity as was the case prior to 2015’s economic slump (Chart 6). The drop in the A-share market in January was nothing compared with the turmoil in the financial markets seven years ago. Chart 5Economic Activity Picked Up In Q1 2016 Following A Massive Stimulus Chart 6China's Economy In General Is In A Better Shape Now Than In 2014/15... On the other hand, the housing market, which is estimated to account for about 29% of China’s economy, is currently decelerating at the same pace as in 2014/15. Growth in home sales and new projects dropped to their 2015 lows, while real estate inventories are comparable to the 2015 highs (Chart 7). Furthermore, property developers and consumers are even more indebted than during the 2014/15 cycle (Chart 8). Chart 7...But Downward Momentum In Property Market Comparable To 2015 Chart 8Chinese Real Estate Developers And Households Are More Leveraged Now Than In 2015 Chart 9Policymakers Will Have To Allow Significant Re-leveraging To Revive The Housing Market As noted in a previous report, unless regulators are willing to initiate more aggressive policy boosts as in 2015/16, the ongoing easing measures will not be sufficient to revive sentiment in the property market. Thus, the property market downtrend will likely extend through 2022 (Chart 9). The IMF recently revised its 2022 growth projection for China from 5.6% to 4.8%. It attributed the sharp downgrade to China’s protracted financial stress in the housing sector and pandemic-induced disruptions related to a zero-tolerance COVID-19 policy. A sub-5% economic expansion in 2022, although still an improvement from the 4.5% average annual rate in 2H21, is subdued and below China’s potential growth. Such a weak economic recovery will weigh on investor sentiment towards Chinese stocks in the coming year. A deceleration in fiscal impulse in 2H22. The impulse in fiscal stimulus - without any intervention - will fall sharply in the second half of the year. The Ministry Of Finance has approved a quota of RMB1.46 trillion in local government special purpose bonds (SPBs), which accounts for more than one-third of the yearly SPB quota, to be issued in Q1 this year. Chart 10Large Amount Of Local Government Debts Due In 2H22 However, the frontloading of SPBs also means that the fiscal impulse will slow significantly in 2H22. Our geopolitical strategists have noted that a total of RMB2.7 trillion worth of local government bonds (LGB) will reach maturity this year, with RMB2.2 trillion coming due after June 2022 (Chart 10). The number of maturing LGBs in 2H22 will be only slightly smaller than those in all of 2021; in 2021 42% of LGBs issued were re-financing bonds to pay off existing local government debts, undermining real fiscal support for the economy. Furthermore, authorities have not loosened their grip on implicit local government debts (Chart 11). These so-called shadow banking debts through local government financing vehicles (LGFVs) are an important source of funding for investments in infrastructure projects. If the central government does not reverse its efforts to curb hidden debts while explicit fiscal stimulus also wanes, then we will likely see a sharp deceleration in fiscal support in 2H22. Lastly, we think Chinese policymakers are still serious about preventing “flood irrigation” type of stimulus, and will not opt for it unless the economic slowdown is much sharper. In Q1 2019 stock prices jumped sharply, boosted by an above-expectation pace of local government SPB issuance and credit expansion. However, following the public spat between Premier Li Keqiang and the PBoC over whether the January 2019 credit spike represented “flood irrigation-style” stimulus, policymakers quickly scaled back credit expansion in Q2 and onshore stock prices ended the year 5% lower than in Q1 (Chart 12). Chart 11Authorities Have Kept Tight Grip On Shadow Banking Activity Chart 12Policymakers Scaled Back Stimulus And Took The Wind Out Of Onshore Stocks In 2019 Carbon emission reduction targets are still viable. In the current 14th Five-Year Plan (2021-2025), the cumulative targets reduction in energy consumption intensity is 13.5%.1 Last year’s energy crisis slowed the de-carbonization process and energy consumption intensity fell by 2.7% in 2021, missing the official annual target of 3%. To meet the de-carbonization target by 2025, energy consumption intensity will have to be lowered by at least 2.7% per year in the next four years. If energy- and carbon-intensive infrastructure activity picks up sharply in 1H22, then policymakers will have to renew their vigilance to constrain carbon-intensive activities later this year. The de-carbonization target has become a key parameter for assessing the performance of local governments, and meeting de-carbonization targets is particularly important given the rotation of local officials will be completed in late 2022. Furthermore, the initiative to reduce energy intensity reflects China’s commitment to move to a green economy. Given the important political events in both China and the US in the fall of 2022, meeting the annual de-carbonization target will be an important projection of China’s international image and will likely play a role in US-China negotiations. Chart 13Prior To The Pandemic, Chinese Stocks Had Little Correlation With US Treasury Yields Higher bond yields in the US and tighter global liquidity conditions. Historically, Chinese onshore stocks have exhibited a loose cyclical correlation with US government bond yields (Chart 13). Nonetheless, if US bond yields rise more than global investors expect and to a level that is economically restrictive, then capital expenditures and household consumption in the US will weaken. This, in turn, will weigh down global trade and Chinese exports of manufactured goods. Against the backdrop of escalating US bond yields, Chinese onshore stocks may passively outperform their US counterparts because China’s A-share market is heavily weighted in value stocks. However, A-share prices in absolute terms will not be immune to heightened volatility in the global financial markets. The risk-off sentiment across global bourses will discourage portfolio flows into emerging economies including China. On a monthly basis, foreign portfolio net inflows account for less than 1% of the onshore equity market trading volume, but in recent years foreign portfolio inflows have increasingly influenced China’s onshore market sentiment and prices (Chart 14). China’s domestic household savings will not provide much support to stock prices this year. Chinese households have increasingly invested in the domestic equity market in the past few years, given that the authorities have been vigilant in containing price inflation in the property market.2 While we think Chinese consumers will continue rotating investment from property to financial market, household savings growth has fallen sharply since mid-2021, which means there have been less available funds to invest in the stock market (Chart 15). Chart 15Chinese Households' Quickly Diminishing Dry Powder Chart 14Foreign Investors Have Become More Influential In The Chinese Onshore Market Bottom Line: For the time being, the significant risks described above make us reluctant to turn bullish on Chinese stocks in both absolute and relative terms. Investment Conclusions There are few upsides related to Chinese onshore stocks in the next 6 to 12 months. However, there are two risks to our underweight stance on Chinese onshore stocks: First, we cannot rule out the possibility that Chinese policymakers will go “all in” for economic stability and allow a significant credit overshoot. In this scenario, a strong pickup in credit growth will produce a rebound in profit growth and support share prices in absolute terms and relative to global equities. Secondly, recent gyrations in global financial markets, coupled with China’s sluggish domestic economy, have triggered shakeouts in the onshore equity markets. The pullback in stock prices has helped to shed some excesses in Chinese stock valuations. Chart 16In Very Optimistic Scenario Chinese Stocks Would Have Some Upside Potential Vs. Global If the stimulus in the next 6 to 12 months returns Chinese corporate profit growth to their 2021 peaks, then Chinese stock prices (in absolute terms) will also approach or go back to their early-2021 highs. Chart 16 highlights that reverting to these levels would imply a return of about 10-15% for domestic stocks in both absolute and relative price terms. We think China’s potential to command a higher multiple than global stocks is capped, barring a major structural improvement in earnings growth. However, Chart 16 (bottom panel) shows that Chinese onshore stocks at their height early last year were still cheaper than their global counterparts. Therefore, in a scenario where Beijing does “whatever it takes” to stimulate its economy, we will have no strong reasons to argue against a return of domestic forward multiples and a strong earnings growth back to levels seen in early-2021. Jing Sima China Strategist jings@bcaresearch.com Footnotes 1 Energy consumption intensity refers to energy consumption per unit of GDP. 2 There was a sharp jump in demand in 2020 for investment products from households; mutual funds in China raised money at a record pace, bringing in over 2 trillion yuan ($308 billion), which is more than the total amount in the previous four years. Strategic Themes Cyclical Recommendations Tactical Recommendations
Equity markets had a hard time digesting the recent increase in interest rates. The 27 basis point rise in the 10-year Treasury yield in January caused the S&P 500 to selloff by 5.3%. Going forward, we expect the pace of increase in bond yields to…
A dominant market theme this year is rising global government bond yields as central banks exit ultra-accommodative monetary policy and attempt to stymie inflationary pressures. The equity market implication of rising bond yields is to favor sectors and…
Executive Summary The European Central Bank (ECB) has engaged in a decisive pivot toward higher policy rates. Markets are pricing in a first interest-rate hike in July and three more increases thereafter in 2022. This is too much for one year. Limited domestic inflationary pressures, weakness in long-term inflation expectations, economic slack, and vulnerability in the periphery will limit the ECB to one hike in December. Nonetheless, the ECB will increase interest rates more than the market anticipates beyond 2022. The UK is setting up for a dangerous latter half of 2022. Too Much Now, Not Enough Later Bottom Line: Bet on a steepening of the euro short-term rate (€STR) curve. Current pricing for 2022 is too aggressive; however, it is too timid beyond the yearend. European financials will be the prime beneficiary of this tilt. Feature On Thursday, February 3, ECB President Christine Lagarde announced a decidedly hawkish pivot at the ECB press conference. The Frankfurt-based institution, worried by higher-than-anticipated inflation, no longer excludes rate hikes for 2022. In a context in which the BoE is resolutely hiking rates and the Fed is ready to initiate a sustained tightening campaign, investors are pricing in a 10bp ECB rate hike as early as July 2022. They also foresee three additional increases by the end of the year. We agree that the ECB will start lifting the deposit rate this year; however, we expect the tightening to begin in December. Nonetheless, we expect the ECB to lift policy rates more aggressively than the €STR prices in subsequent years. European Inflation Is Different Chart 1Surprise! The knee-jerk reaction of investors to price in a sudden, sustained campaign of ECB rate hikes this year similar to that of the Fed is natural in light of elevated Eurozone inflation and inflation surprises (Chart 1). However, we continue to view European inflation as distinct from US inflation. European inflation remains dominated by dynamics in the energy market. While headline inflation increased from 5% to 5.1% in January, the core Consumer Price Index (CPI) declined modestly to 2.3% from 2.6%. Crucially, the variance of headline CPI is still almost fully explained by the variance of its energy component (Chart 2, top panel). However, it is concerning that there is also evident pass-through from energy prices to core CPI taking place today (Chart 2, bottom panel). Naturally, natural gas prices play a particularly important role in this energy-driven inflation spike (Chart 3). Chart 2Energy Still Drives Inflation Chart 3Natural Gas Remains Key Imported inflation is another key driver of European inflation. Chart 4 highlights that there is a robust relationship between the level of headline Harmonized Index of Consumer Prices (HICP) across EU nations and their import prices. This confirms that a large proportion of the European inflationary outburst has taken root outside of the continent’s borders. Chart 4Imported Inflation? Despite this energy-driven, imported inflation, domestic pressures are still much more muted than those in the US. VAT increases played an important role in pushing core CPI higher. Without this contribution, CPI excluding food and energy would be 50 bps lower (Chart 5). Meanwhile, rent inflation remains a modest 1.1%, which is significantly lower than that in the US (Chart 6, top panel), whereas used car CPI is not nearly as extreme as across the Atlantic (Chart 6, bottom panel). Chart 5Elevated Contribution From Taxes Chart 6Comparatively Muted Domestic Inflation Drivers Wage dynamics too are not yet as concerning in the Eurozone as they are in the US. Negotiated wages remain near a record low of 1.4%, and unit labor costs at 0.9% are still inconsistent with strong underlying inflationary pressures (Chart 7, top and second panel). The labor market is tightening and the Euro Area unemployment rate fell to a new low at 7%. However, the total hours worked have not yet reached their pre-pandemic levels (Chart 7, third panel), which suggests that it could take a few more months before the dislocation caused by the pandemic has been fully absorbed and wages become a risk. That being said, it is only a matter of time, as job vacancies are skyrocketing (Chart 7, bottom panel). Chart 8Plentiful Slack Chart 7The Labor Market Will Heat Up... Later The European output gap also limits a repetition of the wage-price spiral taking hold in the US. The OECD’s Weekly Tracker of GDP, a proxy for the overall Eurozone comprised of Germany, France, Italy, and Spain, reveals that, as of mid-January, aggregate output was still 4.9% below its pre-pandemic trend (Chart 8, top panel). Looking at the actual GDP of European countries individually, only France stands above its pre-pandemic trend, whereas Germany, Italy, and Spain still linger well below the average economic path that prevailed from 2012 to 2019 (Chart 8, bottom panels). Chart 9The Inflationary Role Of Bottlenecks Bottlenecks have also played an important role in relation to higher inflation. Goods inflation is much more elevated than services inflation (Chart 9, top panel), and industrial companies rank the ability to procure equipment and materials as their most important production constraint (Chart 9, second panel). However, production bottlenecks are dissipating. A recent Ifo survey highlights that the proportion of retailers with procurement issues declined from 82% in December 2021 to 57% in January 2022. Moreover, the supplier deliveries indexes of the PMIs are improving across the world. In fact, our simple Supply Disruption Index has begun to rollover, which points toward an imminent end to the wave of inflation surprises (Chart 9, bottom panel). European inflation expectations bear the imprint of those more modest domestic inflationary pressures, which explains the comparatively more limited wage-price spiral on the continent. The inflation expectations of Eurozone households are rising, but they are still within the norm of the past 20 years. In the US, they are breaking out. Moreover, our Index of Common Inflation Expectations, designed to mimic the New York Fed’s measure, remains well contained and is tentatively rolling over (Chart 10). Collectively, these forces explain the radically different inflation profiles of the Euro Area and the US. On the western shore of the Atlantic, the two-year annualized rate of change of the core CPI has completely shattered its highs of the past 20 years, indicating that more than simple base-effects are contributing to inflation (Chart 11, top panel). Meanwhile, the two-year annualized rate of change of the European core CPI is higher than the past deflationary eight years, but it is still low compared to the rates that prevailed prior to the European sovereign debt crisis (Chart 11, bottom panel). Chart 10Inflation Expectations: Unlike The US Chart 11Realized Inflation: Unlike The US Chart 12The Coming CPI Peak? Going forward, there remains a high likelihood that Eurozone inflation will soon peak. The impact of the German VAT increases will soon dissipate from the data, energy inflation will diminish as the annual rate of change of oil and natural gas prices peaks, and the growth in monetary aggregates has normalized sharply. Most importantly, in the absence of significant domestic inflationary pressures, the sharp decline in the ZEW Inflation Expectations components point toward a deceleration in headline HICP (Chart 12). Nonetheless, we cannot be too sanguine. The European output gap is likely to close this year and wages pressures will emerge before the end of 2022. As a result, inflation will not fall below 2% anytime soon. Moreover, as we wrote last week, any long-lasting crisis in Ukraine will prevent energy inflation from declining, and thus, there remains significant upside risk to our inflation view in the coming months. Bottom Line: European inflation remains dominated by energy prices and imported price pressures. For now, domestic inflation dynamics are still mild, which explains why Europe’s inflation profile is much shallower than that of the US. Moreover, the near-term picture suggests that the imported inflation will peak, giving a respite to the HICP. Nonetheless, toward the yearend, domestic inflationary forces will pick up as wages gain traction. ECB Pricing: Too Much And Too Little ECB President Christine Lagarde delivered a message that was loud and clear: The ECB is abandoning its ultra-dovish stance. Despite this policy pivot, investors are pricing in too many hikes this year, whereas we only expect one rate increase toward yearend. True, if energy prices spike anew, risks to this forecast will be skewed to the upside. Nonetheless, we are inclined to fade the number of rate hikes priced in for 2022 and bet for more hikes in 2023 and 2024 (Chart 13). Chart 13Too Much Now, Not Enough Later Why does our base case only include one rate hike in December? First, we are considering the entirety of the inflation picture. As we argued above, inflationary dynamics in Europe are much tamer than those in the US, especially in terms of domestic inflation, which the ECB can influence. Moreover, the ECB is still reeling from its infamous 2011 policy mistake, which accentuated underlying deflationary pressures and caused the ECB to undershoot its mandate for eight years in a row (Chart 14). Inflation expectations also offer some leeway to the ECB. Predictions by professional forecasters continue to track below two percent for the medium term. Importantly, market-based inflation expectations remain consistent with a temporary inflation shock, and do not meet yet the ECB’s criteria of being above the 2% target durably. 10-year CPI swaps hover around 2%, driven by the jump in 2-year CPI swaps to 2.7%. Long-dated expectations approximated by the 5-year/5-year forward CPI swap remain below 2% and the inflation curve is its most inverted on record (Chart 15). Chart 15Inflation Swaps Don't Fit The ECB's Criteria Chart 14The Legacy Of The 2011 Mistake In the end, President Lagarde did mention in the press conference that inflation is finally moving toward its target after years of undershoot. In the context described above, it is likely that the ECB will continue to tolerate some higher inflation in the near term if it represses the deflationary mentality that had engulfed the Eurozone last decade and caused a progressive Japanification of the region. This is a small price to pay to exit at last the lower bound of interest rates on a durable basis. Second comes the sequencing of policy. President Lagarde reiterated the importance of the order of events. First, the ECB will have to bring asset purchases to a net zero before lifting rates. It has yet to curtail purchases. The March meeting will be of paramount importance, since it will feature the tapering schedule of the central bank. We continue to see a progressive pace of declining assets purchases that will likely end in September 2022. Moreover, the ECB will want to see how the European economy and markets will absorb the TLTRO cliff this June, when EUR1.3 trillion of facility expire. Chart 16The Italian Constraint Third, the ECB remains hamstrung by financial dynamics in the periphery. On Thursday, as Bund yields rose 10 basis points, BTP yields rose 21 basis points, bringing the Italian-German spread to 150bps, its highest level since September 2020 (Chart 16). Simply put, the periphery remains fragile because Italy and Spain sport some of the most negative output gaps in the region. Waiting for a stronger position out of those countries would let the ECB increase rates further down the road, allowing for a cleaner exit from negative policy rates in Europe. While these factors continue to favor a cautious posture by the ECB in 2022 and, therefore, support our base view of only one 10bps hike in December to be flagged when net purchases end in September, they will evolve and allow for many more hikes in 2023 and 2024. We expect the following developments to unfold: The output gaps across the region will close this year, which will put the economy in a position of strength and generate stronger domestic inflationary pressures down the road. Salaries will begin to accelerate meaningfully by the summer. This force will accentuate domestic inflationary pressures in late 2022 and 2023, and will contribute to higher household inflation expectations. The periphery will grow increasingly stronger as the Next Generation EU (NGEU) disbursements accelerate in 2022 and 2023. These disbursements are primarily geared toward infrastructure/capex spending (Chart 17) and will therefore sport elevated fiscal multipliers. The resulting strength will provide more resilience to the periphery and limit the tightening of financial conditions caused by higher interest rates. Chart 17The NGEU Will Matter… A Lot Chart 18Terminal Rates Are Too Low In the longer term, we also believe that markets still understate the ability of the ECB to lift rates. The market-derived terminal rate proxy for Europe is in the vicinity of the levels recorded in the wake of the European sovereign debt crisis last decade (Chart 18). Fiscal policy is more generous, however, and thus domestic demand is stronger. As a corollary, the accelerator model implies that capex will be more robust than it was last decade. Finally, the European Union is not as politically divided as it once was, which creates a stronger block. Together, these developments suggest that the r-star or the neutral rate of interest in the Euro Area is higher than last decade. Bottom Line: The €STR curve is pricing in the potential path of the ECB this year too aggressively. The ECB is likely to start raising rates in December, not in July. Domestic inflation and inflation expectations remain too modest, while the periphery remains fragile. Moreover, the ECB will stick to the previously decided sequence that calls for an end to net asset purchases ahead of hikes. Beyond 2022, we expect the ECB to increase rates more than what is priced into the €STR curve. Investment Implications The first implication of our view is that the European yield curve is likely to steepen further in the coming year. This is true in absolute terms but also relative to the US. We remain long European steepeners relative to US ones. Second, we continue to favor European financials. European banks are a direct equity play on higher yields and on a steeper yield curve (Chart 19). Moreover, European financials have upside relative to their US competitors. They are cheap, and they will benefit from the relative steepening in the European yield curve (Chart 20). Additionally, European monetary conditions will remain easier this year than US ones, whereas European growth will continue to catch up to the US. Chart 20Roll Over XLF Chart 19Banks Will Shine More Chart 21A Bit More Stress Third, the equity market correction might have a little more to run. In the near term, equities had become very oversold. This week’s bounce makes sense after the S&P 500’s RSI plunged below 30. However, hedge funds are not shorting the market as violently as they did in 2018, yet all the major global central banks (apart from the BoJ) are abandoning their pandemic-driven policy. As a result of the prospect of a global decline in liquidity, a retest of the 2018-lows in net exposure is likely as we approach the March Fed meeting, especially as credit spreads are still too low to cause a meaningful change in tone by the Fed (Chart 21). Thus, European stocks could experience another wave of selling in the coming weeks, especially when the risks surrounding Ukraine have yet to clear. Keep some protections in place. Finally, the euro has surged this week. With looming Ukrainian risk, the potential for a repricing downward of the near-term European policy rates and the risk of a last sell-off in equities, the euro could give up some of its recent gains and remain in a churning pattern, in place since December 2021. The uncertainty is therefore elevated for near-term traders. However, considering last week’s ECB pivot and the likelihood of an upward revision of the €STR curve for 2024 rates, long-term investors should use a pull back in the euro in the coming weeks to gain exposure to long EUR/USD. What About The BoE? Last week, the Bank of England increased rates by 25bps to 0.5%, which was a widely expected move. The BoE is naturally ahead of the ECB because inflation swaps stand at 4.3% and are even higher than those in the US. The BoE is forced to be more aggressive because inflation expectations are becoming unmoored, which raises the risk of a wage-price spiral north of the Channel. This is a legacy of years of higher inflation and of the labor-supply problems created by Brexit. Additionally, the UK is exiting Omicron lockdowns faster than the Euro Area, which accentuates its near-term economic strength. The UK is not, however, out of the woods. A perfect storm is brewing for the remainder of the year. Interest rates are set to rise sharply, energy price caps will disappear in two months, and the budget is anticipating a significant tightening in the coming quarters after taxes rise in April. This will hurt economic activity in the latter half of the year and will cause tensions in the domestic market. The tax hikes are not guaranteed and a reversal is still possible. PM Boris Johnson is currently embroiled in the so-called “Partygate” scandal and Rishi Sunak, Chancellor of the Exchequer, is seen as the most likely candidate within the Conservative Party to replace Johnson if he were to be pushed out of power by the 1922 Committee. As a colleague observed, it remains to be seen whether Sunak’s political ambitions will scuttle his fiscal rectitude. Nonetheless, the threats to UK small-cap stocks are increasing, warranting a cautious stance if the tax increases are not revoked in the coming weeks. Mathieu Savary, Chief European Strategist Mathieu@bcaresearch.com Tactical Recommendations Cyclical Recommendations Structural Recommendations Closed Trades
Executive Summary Inflation has broken out to 40-plus-year highs in the US and is rapidly becoming a pressing issue for major central banks around the world. Financial markets are vulnerable to upside inflation surprises, which could induce the Fed and its peers to pursue markedly less friendly monetary policy. Despite the ongoing surge in consumer and producer prices, longer-term inflation expectations remain firmly anchored at low levels. Surveys and market prices betray no concern about a lasting inflection. We have ticked a majority of the boxes on our inflation checklist, but we will remain constructive on risk assets as long as inflation expectations remain well-behaved. Long-Run Inflation Expectations Are Well Anchored Bottom Line: The Fed will only slam on the brakes if long-run inflation expectations break out, opening the door to a vicious circle in which inflation begets inflation. Risk assets will outperform this year unless expectations become unmoored. Feature We will be holding our quarterly webcasts next Monday, February 14, for clients in EMEA and the Americas and Tuesday, February 15, for Asia-Pacific clients in lieu of publishing a Weekly Report. Please join us with your questions to make it a fully interactive event. We will resume our regular publication schedule on the 21. Chart 1Inflation And The Fed Have Markets On Edge When we assembled our inflation checklist last May, the future path of consumer prices was still quite uncertain. At the time, the drivers of elevated inflation readings were concentrated in categories that had suffered the worst pandemic disruptions, like air fares, hotels, new cars, used cars, rental cars and auto insurance, and it was unclear how much upward price pressures would spread more broadly across the economy. Delta and Omicron had yet to worsen existing supply chain tangles. While inflation was sure to exceed its post-crisis levels for an extended period, it was not at all clear that it would do so by a significant margin. Now that inflation has broken out to Volcker-era highs, investors’ focus is squarely on the Fed’s response. Fears that inflation would prompt the Fed to tighten policy more and faster than previously expected underpinned the selling spasm that stretched across the last two full weeks of January (Chart 1). The equity market had moved on from the Fed outlook before Friday’s employment report pushed the 10-year yield to a new pandemic high, but it promises to be a recurring theme until the impending rate hike cycle is complete. Turning to our checklist, we contend that inflation expectations hold the key to the Fed’s reaction and that they continue to hold fast as a bulwark against the Fed adopting a war footing that would torpedo financial markets and the economy. Making A List (And Checking It Seven Times) It doesn’t take a certified market technician to confirm that inflation has broken out (Chart 2). It doesn’t take our checklist, either, though we’ve now checked seven of its twelve boxes (Table 1). Its purpose wasn’t to replace what investors could see with their own eyes but rather to augment it with a framework for assessing future inflation moves and their impact on monetary policy settings. We do not expect that the FOMC will bring the party to an abrupt end while investors, businesses and consumers remain untroubled about long-run inflation. Chart 2Breakout Table 1Inflation Checklist Though we think the Inflation Expectations boxes are the key, we make a full tour through the checklist to spotlight the data behind each line. We have ticked the Labor Supply/Utilization box, despite the still-low labor force participation rate (Chart 3, top panel) because the evidence suggests it is not going to return to its pre-pandemic level any time soon. The prime age employment-to-population ratio has made much more steady progress and is back within the range of the last three expansions, suggesting that the economy has returned to full employment with the exception of industries hit hardest by the pandemic1 (Chart 3, bottom panel). Chart 3The Economy Is Closing In On Full Employment ... Labor demand continues to soar, with nearly half of all respondents to the NFIB survey indicating that they have unfilled job openings and the Department of Labor’s job openings rate routinely setting new records (Chart 4). The combination of roaring demand and limited supply would seem to be a recipe for salary and wage growth, but it still hasn't come to pass. Though the main wage series have all picked up in nominal terms (Chart 5), the supply/demand imbalance has yet to produce compensation increases that can outpace inflation (Chart 6). Rampant concerns that wage gains will drag on corporate profit margins have yet to materialize and we leave the wage box unchecked. Chart 4... And Demand For Workers Is Still Exploding Chart 5Nominal Wage Gains Look Large, ... Chart 6... But They're Lagging Inflation The breakouts in the marquee core CPI (Chart 7, top panel) and PCE (Chart 7, bottom panel) indexes have captured a lot of attention, but their trimmed-mean measures have quietly overtopped their longstanding ranges as well. The trimmed-mean series, which throw out the outliers at both ends of the distribution, supported the transitory view last summer but are now confirming that the underlying pace of consumer price increases has materially quickened. Chart 7It's Not Just About The Outliers Anymore As for future inflation, our pipeline inflation indicator has eased over the last few months (Chart 8, top panel), but remains elevated and the preponderance of other cost pressure evidence keeps us from unchecking its box. Dollar strength has helped to guard against imported inflation pressures (Chart 8, bottom panel). They have been tame so far, but with inflation breaking out in Europe (Chart 9, top panel) and just about every major economy except China (Chart 9, bottom panel), rising import costs are likely to add some inflation momentum at the margin. Chart 8The Dollar's Tailwind Has Been An Inflation Headwind, ... Chart 9... But Inflation's Become A Problem Everywhere But China The Levees Are Holding Firm Although we checked six of the first eight boxes, we maintain a sanguine view about inflation’s impact on monetary policy and financial markets. Some of the boxes are more equal than others, and if we had to pick just one indicator to determine whether inflation will compel the Fed to take stern action, it would be the shape of the inflation expectations curve. Inflation begins to beget inflation when economic actors – workers, businesses, consumers and lenders – begin to expect it will linger into the future and change their behavior to align with their expectations. When inflation is expected to remain persistently high over the long term, individual workers or their unions insist on higher wages to maintain purchasing power, businesses at all points of the supply chain demand higher prices to protect their margins, consumers accelerate their big-ticket purchase decisions to get the most bang for their buck and lenders require higher nominal pro forma returns. The resulting feedback loops help inflation become entrenched in the same way that expectations of falling prices have paved the way for a deflationary mindset to grip Japan. Despite all the attention that rising prices have drawn, investors (Table 2) and households (Chart 10) continue to expect inflation to decelerate from the short term to the intermediate term, and again from the intermediate term to the long term. As long as economic actors are unconcerned about the longer-term picture, the Fed will be able to remove accommodation at a deliberate pace that will not pull the rug out from under financial markets. Table 2These Inverted Curves ... Chart 10... Are Good Omens To that end, the FOMC has heretofore limited itself to open mouth operations. Chair Powell may have talked tough at last month’s post-meeting press conference, but the committee passed on the chance to terminate the asset purchase program early. A rate hike is all but assured at the next meeting in mid-March and Powell indicated that investors should expect the Fed to move faster than the 25-basis-points(bps)-every-other-meeting pace of the last tightening cycle, but our US Bond Strategy team is inclined to bet the under on the money market’s 125-bps full-year expectation. We have checked the commentary box but are not going to check the dots box ahead of the March meeting’s update. It is further possible that the Fed’s expressed concerns about inflation will reduce the need for it to take action to combat it. We have previously cited our Global Fixed Income Strategy colleagues’ view that investors need only worry about inflation when central banks don't. One-year inflation expectations have come down considerably and intermediate- and long-term expectations have eased since late November (Chart 11), when Omicron’s emergence and the Fed’s hawkish pivot stirred concern. Omicron caused less supply-side disruption than initially feared and markets have relaxed a little now that the inflation cop is once again walking the beat. Chart 11Long-Term Expectations Stay Put, No Matter What Happens At The Short End Investment Implications Ever since the year began, we have stressed the point that tighter policy is not necessarily tight policy. Economic and market inflection points are conditioned upon the level of the fed funds rate, not its direction. Restrictive monetary policy settings are not yet in sight and we doubt that they will emerge in time to shadow risk assets’ 2022 prospects. We like the tighter-does-not-equal-tight formulation, but it obscures an important nuance. Strictly speaking, the Fed is not tightening monetary policy when it tapers its monthly asset purchases – it’s merely dialing down the level of monetary accommodation. Similarly, raising the target fed funds rate from an emergency range of 0 to ¼% two years after COVID reached the US and several months after it ceased to be an acute threat merely reduces the level of monetary stimulus. Even if the FOMC does deliver 125 bps of hikes by year end, lifting the funds rate to 1⅜%, it will still be egging on the economy because no one believes the neutral rate is 1⅜% or lower. Removing accommodation is more like easing up on the gas than squeezing the brakes. As long as inflation doesn’t scare economic participants, causing their longer-run inflation expectations to become unmoored, the Fed will be able to reduce monetary stimulus in an incremental fashion akin to applying less pressure to the gas pedal. That does not mean investors can forget about the Fed; we expect policy scares will roil financial markets off and on throughout the rest of the year. Ultimately, though, we think the elevated volatility will prove unfounded as our base case is that the Fed will not have to slam on the brakes. The steeply downward sloping inflation expectations curve suggests that it will take a lot for expectations to reset but we will be keeping an eye on it nonetheless, because uncomfortably high inflation, and the Fed’s eagerness to counter it, remains the biggest risk to our view. Doug Peta, CFA Chief US Investment Strategist dougp@bcaresearch.com Footnotes 1 Per the January Employment Situation Report, Leisure and Hospitality now accounts for nearly 60% of nonfarm payroll and 97% of private sector service employment losses since February 2020.
BCA Research is proud to announce a new feature to help clients get the most out of our research: an Executive Summary cover page on each of the BCA Research Reports. We created these summaries to help you quickly capture the main points of each report through an at-a-glance read of key insights, chart of the day, investment recommendations and a bottom line. For a deeper analysis, you may refer to the full BCA Research Report. Executive Summary The golden rule for investing in the stock market simply states: “Stay bullish on stocks unless you have good reason to think that a recession is imminent.” The catch, of course, is that it is difficult to know whether a recession is lurking around the corner. Still, we can learn a lot from past recessions. As we document in this week’s report, every major downturn was caused by the buildup of imbalances within the economy, which were then laid bare by some sort of catalyst, usually monetary tightening. Today, the US is neither suffering from an overhang of capital spending, as it did in the lead-up to the 2001 recession, nor an overhang of housing, as it did in the lead-up to the Great Recession. US inflation has risen, but unlike in the early 1980s, long-term inflation expectations remain well anchored. This gives the Fed scope to tighten monetary policy in a gradual manner. Outside the US, vulnerabilities are more pronounced, especially in China where the property market is weakening, and debt levels stand at exceptionally high levels. Fortunately, the Chinese government has enough tools to keep the economy afloat, at least for the time being. Equity Bear Markets And Recessions Go Hand In Hand Bottom Line: Equity bear markets rarely occur outside of recessions. With global growth set to remain above trend at least for the next 12 months, investors should continue to overweight equities. However, they should underweight the tech sector since tech stocks remain disproportionately vulnerable to rising rates, increased regulation, and a retrenchment in pandemic-induced spending on electronics and online services. Macro Matters Investors tend to underestimate the importance of macroeconomics for stock market outcomes. That is a pity. Charts 1, 2, and 3 show that the business cycle drives the evolution of corporate earnings; corporate earnings, in turn, drive the stock market; and as a result, the business cycle determines the path for stock prices. Chart 1The Business Cycle Drives Earnings… Chart 2…Earnings In Turn Drive Stock Prices… An appreciation of macro forces leads to our golden rule for investing in the stock market. It simply states: Stay bullish on stocks unless you have good reason to think that a recession is imminent. Chart 3…Hence, The Business Cycle Is The Main Driver Of Equity Returns Historically, stocks have peaked about six months before the onset of a recession. Thus, it usually does not pay to turn bearish on stocks if you expect the economy to grow for at least another 12 months. In fact, aside from the brief but violent 1987 stock market crash, during the past 50 years, the S&P 500 has never fallen by more than 20% outside of a recessionary environment (Chart 4). Peering Around The Corner The catch, of course, is that it is difficult to know whether a recession is lurking around the corner. Leo Tolstoy began his novel Anna Karenina with the words “Happy families are all alike; every unhappy family is unhappy in its own way.” By the same token, every economic boom seems the same, whereas every recession has its own unique features. This makes forecasting recessions difficult. Difficult, but not impossible. Even though recessions differ substantially in their magnitude and causes, they all share the following three characteristics: 1) The buildup of imbalances that make the economy vulnerable to a downturn; 2) A catalyst that exposes these imbalances; and 3) Amplifiers or dampeners that either exacerbate or mitigate the slump. Let us review six past recessions to better understand what these three characteristics reveal about the current state of the global economy. Chart 4Equity Bear Markets And Recessions Go Hand In Hand The 1980 And 1982 Recessions The double-dip recessions of 1980 and 1982 were the last in which inflation played a starring role. Throughout the 1970s, the Fed consistently overstated the degree of slack in the economy (Chart 5). This led to a prolonged period in which interest rates stayed below their equilibrium level. The resulting upward pressure on inflation from an overheated economy was compounded by a series of oil shocks, the last of which occurred in 1979 following the Iranian revolution. Chart 6The Volcker Era: It Took Massive Monetary Tightening To Bring Down Inflation Chart 5The Fed Continuously Overstated The Magnitude Of Economic Slack In The 1970s In an effort to break the back of inflation, newly appointed Fed chair Paul Volcker raised rates, first to 17% in April 1980, and then following a brief interlude in which the effective fed funds rate dropped back to 9%, to a peak of 19% in July 1981 (Chart 6). The 1990-91 Recession Overheating also contributed to the early 1990s recession. After reaching a high of 10.8% in 1982, the unemployment rate fell to 5% in 1989, about one percentage point below its equilibrium level at that time. Core inflation began to accelerate, reaching 5.5% by August 1990. The Fed initially responded to the overheating economy by hiking interest rates. The fed funds rate rose from 6.6% in March 1988 to a high of 9.8% by May 1989. By the summer of 1990, the economy had already slowed significantly. Commercial real estate, still reeling from the effects of the Savings and Loan crisis, weakened sharply. Defense outlays continued to contract following the collapse of the Soviet Union. The final straw was Saddam Hussein’s invasion of Kuwait, which caused oil prices to surge and consumer confidence to plunge (Chart 7). The 2001 Recession An overhang of IT equipment sowed the seeds of the 2001 recession. Spending on telecommunications equipment rose almost three-fold over the course of the 1990s, which helped lift overall nonresidential capital spending from 11.2% of GDP in 1992 to 14.7% in 2000 (Chart 8). Chart 7Overheating In The Leadup To The 1990-91 Recession The recession itself was fairly mild. After subsequent revisions to the data, growth turned negative for just one quarter, in Q3 of 2001. However, due to the lopsided influence of the tech sector in aggregate profits – and even more so, in market capitalization – the dotcom bust had a major impact on equity prices (Chart 9). Chart 9The Dotcom Bust Dragged Down Tech Earnings Chart 8A Glut Of I.T. Equipment Sowed The Seeds Of The 2001 Recession Having raised rates to 6.5% in May 2000, the Fed responded to the downturn by easing monetary policy. Falling rates were effective in reviving the economy – indeed, perhaps too effective. The resulting housing boom paved the way for the Great Recession. The Great Recession (2007-2009) The housing sector was the source of imbalances in the lead-up to the Great Recession. In the US, and in other countries such as Spain and Ireland, house prices soared as lenders doled out credit on increasingly lenient terms. Chart 10A Long House Party Rising house prices stoked a consumption boom and incentivized developers to build more homes. In the US, the personal savings rate fell to historic lows. Residential investment reached a high of 6.7% of GDP, up from an average of 4.3% of GDP in the 1990s (Chart 10). While the housing bubble would have burst at some point anyway, tighter monetary policy helped expedite the downturn. Starting in June 2004, the Fed raised rates 17 times, pushing the fed funds rate to 5.25% by June 2006. The ECB also hiked rates; it raised the refi rate from 2% in December 2005 to 4.25% in July 2008, continuing to tighten policy even after the Fed had begun to cut rates. Once global growth started to weaken, a number of accelerants kicked in. As is the case in every recession, rising unemployment led to less spending, which in turn led to even higher unemployment. To make matters worse, a vicious circle engulfed the housing market. Falling home prices eroded the collateral underlying mortgage loans, producing more defaults, tighter lending standards, and even lower home prices. The Fed responded to the crisis by cutting rates and introducing an alphabet soup of programs to support the financial system. However, the zero lower-bound constraint limited the degree to which the Fed could cut rates, forcing it to resort to unorthodox measures such as quantitative easing. While these measures arguably helped, they fell short of what was needed to resuscitate the economy. Fiscal policy could have picked up the slack, but political considerations limited the scale and scope of the 2009 Recovery Act. The result was a needlessly long and drawn-out recovery. The Euro Crisis (2012) Chart 11The State Is Here To Mop Up The Mess A reoccurring theme in economic history is that financial crises often force governments to assume private-sector liabilities in order to avoid a full-scale economic collapse. Unlike Greece, where government debt stood at very high levels even before the GFC, debt levels in Spain and Ireland were quite modest before the crisis. However, all that changed when Spain and Ireland were forced to bail out their banks (Chart 11). Unlike the US, UK, and Japan, euro area member governments did not have access to central banks that could serve as buyers of last resort for their debts. This limitation created a feedback loop where rising bond yields made it more onerous for governments to service their debts, which led to a higher perceived likelihood of default and even higher yields (Chart 12). Chart 12Multiple Equilibria In The Debt Market Are Possible Without A Lender Of Last Resort The ECB could have short-circuited this vicious cycle. Unfortunately, under the hapless leadership of Jean-Claude Trichet, instead of providing assistance, the central bank raised rates twice in 2011. This helped spread the crisis to Italy and other parts of core Europe. It ultimately took Mario Draghi’s “whatever it takes pledge” to restore some semblance of normality to European sovereign debt markets. Lessons For Today The current environment bears some resemblance to the one preceding the recessions of the early 1980s. As was the case back then, inflation today has surged well above the Federal Reserve’s target, forcing the Fed to turn more hawkish. Oil prices have also risen, despite slowing global growth. Even Russia has returned to its status as the world’s leading geopolitical boogeyman. Yet, digging below the surface, there is a big difference between today and the early ‘80s. For one thing, long-term inflation expectations remain well anchored. While expected inflation 5-to-10 years out has risen to 3.1% in the latest University of Michigan survey, this just takes the reading back to where it was not long after the Great Recession. It is still nowhere near the double-digit levels reached in the early ‘80s (Chart 13). Market-based inflation expectations are even more subdued. In fact, the widely watched 5-year/5-year forward TIPS breakeven inflation rate is currently well below the Fed’s comfort zone (Chart 14). Chart 13Long-Term Inflation Expectations Are Inching Up But Are Still Low Chart 14Market-Based Long-Term Inflation Expectations Are Below The Fed's Comfort Zone Higher oil prices are unlikely to have the sting that they once did. The energy intensity of the global economy has fallen steadily over time, especially in advanced economies (Chart 15). Today, the US generates three-times as much output for every joule of energy consumed than it did in 1970. Household spending on energy has declined from a peak of 8.3% of disposable income in 1980 to 3.8% in December 2021. The US also produces over 11 million barrels of oil per day, more than Saudi Arabia (Chart 16). Chart 15The Global Economy Has Become Less Energy Intensive Over Time Chart 16When It Comes To Energy Production, The USA Is Now #1 Unlike in the late 1990s, advanced economies do not face a significant capex overhang. Quite the contrary. Capital spending has been fairly weak across much of the OECD. In the US, the average age of the nonresidential capital stock has risen to the highest level since the 1960s (Chart 17). Looking out, far from cratering, capital spending is set to rise, as foreshadowed by the jump in core capital goods orders (Chart 18). Chart 17The Aging Capital Stock Chart 18The Outlook For US Capex Is Bright Chart 19Need More Houses In contrast to the glut of housing that helped precipitate the Global Financial Crisis, housing remains in short supply in many developed economies. In the US, the homeowner vacancy rate has fallen to a record low. There are currently half as many new homes available for sale as there were in early 2020 (Chart 19). Even in Canada, where homebuilding has held up well, government officials have been hitting the panic button over a brewing home shortage. The Biggest Risk Is Debt The biggest macroeconomic risk the global economy faces stems from high debt levels. While household debt has fallen by 20% of GDP in the US, it has risen in a number of other economies. Corporate debt has generally increased everywhere, in many cases to finance share buybacks and M&A activity (Chart 20). Public debt has also soared to the highest levels since during World War II. Chart 20Mo' Debt Among emerging markets, China’s debt burden is especially pronounced. Total private and public debt reached 285% of GDP in 2021, nearly double what it was in early 2008. The property market is also slowing, which will weigh on growth. Like many countries, China finds itself in a paradoxical situation: Any effort to pare back debt is likely to crush nominal GDP by so much that the debt-to-GDP ratio rises rather than falls. Ironically, the only solution is to adopt reflationary policies that allow the economy to run hot. In the near term, this could prove to be a favorable outcome for investors since it will mean that monetary policy stays highly accommodative. Over the long haul, however, it may lead to a stagflationary environment, which would be detrimental to equities and other risk assets. In summary, investors should remain overweight stocks for now. However, they should underweight the tech sector since tech stocks remain disproportionately vulnerable to rising rates, increased regulation, and a retrenchment in pandemic-induced spending on electronics and online services. Peter Berezin Chief Global Strategist peterb@bcaresearch.com Global Investment Strategy View Matrix Special Trade Recommendations Current MacroQuant Model Scores
BCA Research’s China Investment Strategy service recommends investors with a cyclical investment horizon long MSCI China Value Index /Short MSCI China Growth Index. On a cyclical basis, Chinese investable stocks will not be immune to global market selloffs…
Shares of Facebook’s parent company, Meta Platforms Inc, plummeted 26% on Thursday. The collapse follows Meta’s quarterly report which revealed that daily active users declined by 10 million in Q4. Meta’s woes can partially be blamed on company-specific…
2022 has surprised investors with the out-of-the-gate market correction, accompanied by a sharp underperformance of Growth vs. Value as part of repricing of the long-duration assets in the context of the tighter monetary policy. As such, $60 billion more has been allocated towards value than growth mutual funds over the past month – the highest amount since 2002 (top panel). Mean reversion is certainly a risk. A big question is whether there is a significant amount of cash sitting on the sidelines or parked in fixed income mutual funds, waiting to be redeployed into equities? To answer this question, we looked at the net flows into all money markets, retail money fund deposits, and net flows into equities vs. bonds (middle and bottom panels). While YTD’s sharp market correction produced only a small uptick in flows into the money market funds or retail deposits, reallocation from equities into fixed income mutual funds has been running its course throughout 2021. Recently, this trend has started to reverse, with net outflows from equities decelerating. This supports the thesis that market correction was a Growth into Value rotation, without much cash leaving equities. Once a new tighter monetary regime gets priced in, money may flow back into equities from the fixed income mutual funds as There Is (still) No Alternative (TINA) in the environment of rising rates. In addition, it appears that there is plenty of cash sitting in retail money funds that could potentially be redeployed. Bottom Line: It appears that retail investors stayed in equities throughout the correction. However, there is plenty of dry powder sitting on the sidelines in the money market, and bond and income mutual funds, ready to be redeployed into equities, supporting their continued outperformance even in the face of tighter monetary policy.